“Worth”

I get so very tired of analysts, pundits and bloggers assigning an arbitrary dollar value to Facebook and other privately held companies and declaring that amount is what the company is “worth”. I have no problems with valuation, but I do have a problem with equating a perceived valuation as the market value of a […]

I get so very tired of analysts, pundits and bloggers assigning an arbitrary dollar value to Facebook and other privately held companies and declaring that amount is what the company is “worth”. I have no problems with valuation, but I do have a problem with equating a perceived valuation as the market value of a company — more often referred to by the arbitrary and irrelevant term: worth.

Facebook is worth $50 bazillion.
Groupon is worth $15 billion.

These two companies and every other company in the world is only worth one amount: what a buyer is willing to pay for it. We know how much publicly traded companies are ‘worth’ because they are traded on an open market, a market where buyers and sellers determine how much the company truly is worth in 15 minute delayed intervals.1

When a company such as Facebook is assign a dollar value, it is done so by a group of private investors giving it that value based on some confidential data they are shown by the company. There is a lot of implied value and value wrapped up in the fact that the company is not publicly traded.2 These values are never market value because: a) the open market is not able to determine what that price is; b) the company being valued is not subject to the same reporting standards as a public traded company is (thanks SEC).3

Let’s look at valuation in terms of homes because you can easily see the difference.

If you bought a house in 2006 for $1 million dollars, is it worth $1 million today?

Most likely not, we are in a terrible recession and in fact you can’t base current value off of past sales. When you get a real estate license one of the first lessons you are taught is that you need to compare homes sold within the last 6 months — markets fluctuate too much otherwise.

Most home owners will tell you that there is a difference between: market value, assessed value and appraised value. I won’t go into each calculation, but suffice to say:

Market Value is the price an open market is willing to pay for the house. In other words it is the price that you can sell the house for now, at this moment. This is the “true” value of the home and the one that you can rarely predict. This is what people usually are referring to when they ask what something is “worth”.

Assessed value is what your local governing body assigns to your property for purposes of taxing the crap out of you.

Appraised value is the value assigned to your home from an independent 3rd party that looks at the physical conditions of the home and the location it is in to for determining a value. This is also the value that your mortgage can and will often be based on.

So what happens if market value is less than appraised value — well this is when you go “under water” on your home. Essentially you owe more money on your loan for the house, then you could get if you were to sell the home right now.

Back to Facebook

All privately held companies can only be given appraised values and not given market values, unless they are made publicly available for sale. This is a bit trickier with businesses because they are (ideally) profit earning entities — better to compare them to commercial real estate, but that is a topic for another time.4 What I am trying to say is that private investors do their best job to assign an appraised value to companies so that they know if they are getting a good deal on their investment. What these investors cannot, and will not, do is predict market value. They internally estimate what they think fair market value is, but that is as close as they get.

They lose out if they give out their market value estimations. If Facebook knows that private venture firms believe their market value to be X, then they know exactly how much investors are willing to invest and at what return.

In other words if you want to buy Steve’s computer from him and you know that he thinks it is worth $500, but is asking $1000 for it — well you have the upper hand in the negotiation because you know what the minimum he is willing to take for the computer. The opposite is true as well, if Steve knows you have $1200 to spend on a computer, then he knows he what you can afford to pay and will adjust his price based on that information. These same principles apply to the valuation of companies for private investing.

Bottom line: these numbers purporting that Facebook is worth $50 billion is a total load of crap. They perhaps are appraised at that value by one set of investors, but they are hardly worth that much at market value.5

The better question, or perhaps the bigger question with Facebook is: why the hell do they need all this money?

The only possible reason I can think of: they aren’t making money.

A company that isn’t making money and only taking on debt is worth only one thing to me: $0.

I am not one of those venture capital naysayers — there are plenty of great reasons to seek venture capital so that you can get your company going. What I am against is pretending that popularity and profit are equals.

I have no way of knowing if Facebook is profitable — my guess is that it is at the very least a break-even business right now — what concerns me is what they need the cash for. Are they trying to buy talent? What are they building that they need that much money?

Doesn’t matter anyways, this was just my long winded way of telling you that “worth” and “valuation” are two entirely different terms — ones that cannot and should not be used interchangeably.

At least according to the Stocks app on my iPhone. How they trade 15 minutes in the past is beyond me. ↩

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A personal blog by Ben Brooks and is chock full of all sorts of "opinion" and "think pieces". The Brooks Review is a membership-only, no bullshit, site — as such you should really become a member. Read more…